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You look at your paycheck, and then you look at the tuition and fees that even the most “affordable” state colleges and universities charge. You cannot help but panic. How, you wonder, will you ever sock away enough money to help pay for your children’s college education?
The bad news? College tuition and fees are not falling. According to CollegeBoard.org, over the last 30 years (1992-93 and 2022-23), in-state tuition and fees at public four-year institutions increased by $6,070, while private four-year institutions increased by $17,540.
The good news? There are several financial tools available to parents who want to help cover the costs of their children’s college educations. Depending upon how early parents start investing in these tools — these savings accounts and trusts can help parents steadily build a nest egg that their children can tap once it is time to head off to college.
The range of savings vehicles is excellent. However, it also represents a challenge: Parents will have to research their savings options carefully to find the right tool for them and their children.
One of the more popular college savings vehicles is the 529 savings plan that states across the country offer. These programs allow parents to invest after-tax dollars today that can grow on a tax-deferred basis over time. Also, withdrawals that pay for qualified education expenses can be tax-free in most cases. Even better, some states provide state income tax deductions for residents who invest in their 529 plans.
One of the more popular forms of these plans is the Section 529 Prepaid Tuition Plan. Such plans let you buy tuition in today’s dollars. The state running the program then agrees to give you the equivalent amount of tuition in the future. Such plans are a way to give parents some control over rising tuition costs.
Most of these plans come with lifetime investment limits. The limits, though, are high enough so that most parents will not have to worry about soaring past them: Many state 529 plans, for instance, allow parents to invest a maximum of $200,000. But, again, that is a level few will have to worry about hitting.
There are some concerns with 529 plans, however. First, parents researching them should pay particularly close attention to fees. Many plans charge hefty administrative costs that can eat away at parents’ investments. Instead, parents should find a 529 savings plan that charges administrative fees of 1 percent or less of the assets they hold. Fortunately, because many states offer more than one version of the 529 plan, finding an affordable plan should not be overly challenging.
The other challenge? Some 529 plans place strict limits on where children can attend college. If the child decides on attending school out-of-state, the parents could receive less money than they have saved because the school isn’t in the state that serves as the home base for the 529 plan. Again, research is the key. Parents need to ensure that any 529 plan they invest in provides flexibility. Children can change their minds about their preferred college several times. Parents do not want to see their college savings dwindle because of this.
The Coverdell ESA plan offers parents another option for building college savings. These savings vehicles are often used as supplements to 529 plans or other savings vehicles because they only allow parents to invest a maximum of $2,000 in them each year.
Still, there are plenty of positives with these plans. First, there is more freedom associated with Coverdell ESA plans. The funds in them can cover any cost associated with attending college. Parents can even use the money in a Coverdell account to pay the tuition costs for children attending kindergarten through 12th grade.
Parents with more than one child preparing for college can transfer any unused funds from one Coverdell ESA to another. They can also use these remaining funds to start a new Coverdell account for another child.
Coverdell accounts are helpful for tax purposes, too. After-tax dollars can be deposited in a Coverdell account and grow on a tax-deferred basis. In most cases, as long as you withdraw the money for a qualified education expense, withdrawals will also be tax-free. However, there are some limits. Single parents must have a modified adjusted gross income of $110,000 or less to contribute the full $2,000 in a Coverdell. Married parents must make a combined gross income of $220,000 or less to make a full contribution each year.
Also, parents have to stop making contributions to a Coverdell once their children turn 18. If the child does not go to college, the funds in a Coverdell will eventually go to the child, even if they never go to college. That is a significant difference from 529 savings plans. Under those plans, parents can usually take the money back if their children decide not to attend college.
Parents or grandparents can also set up custodial accounts available under the Uniform Transfers to Minors Act (UTMA) or Unified Gift to Minors Act (UGMA). These accounts allow parents or grandparents to invest as much as they would like each year and in total. However, these investments are not tax-free like the Coverdell or 529 plans.
There are plenty of investment choices with UTMA or UGMA accounts, giving parents and grandparents more investment control over their dollars.
The drawback? At either age 18 or 21, children take control of the money in these UTMA or UGMA accounts. Beneficiaries do not have to use the money to pay for college tuition or living expenses. They can instead use it to buy a new car or motorcycle. The money is theirs to do with as they want.
It is easy for parents to let the sheer number of college savings choices overwhelm them. The three main options listed in this story, though, should provide at least a rough blueprint for how parents can sock away dollars for their children’s college education.
The best way to handle college savings, though, is for parents to speak with a licensed financial advisor. Such a pro can help steer them through Coverdells, UTMA accounts, and 529 plans. With some guidance and research, saving for college does not need you to lose sleep.
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